Upgrade of National Credit

Fitch Ratings, one of the world’s three major credit rating agencies, upgraded South Korea’s sovereign credit rating one notch from A+ to AA- on September 6. The nation’s rating outlook has been revised up to Stable in 10 months since the agency raised it to Positive last November.

AA- is the fourth highest among Fitch’s 21 credit ratings and on par with Aa3, a rating given to the nation by Moody’s on August 27. In particular, the latest grade granted to South Korea is one level higher than the A+ ratings for Japan and China. This is first time in history that the nation has beaten Japan in terms of sovereign credit rating.

This result comes seven years after Fitch revised the nation’s rating upwards from A to A+ in October, 2005. The latest achievement marks the first time in 15 years that the nation’s credit rating has returned to its former unblemished level before the 1997 financial crisis. Fitch revised down the nation’s credit rating from AA- to A+ in November, 1997.

What is more, Fitch’s announcement regarding the upgrade is even more encouraging because it comes after Moody’s changed Korea’s credit rating from A1 to Aa3 on August 27. The double A rating entitles the nation to join the ranks of advanced economies. The latest upgrade has trumped the argument that Moody’s acted rashly.

Fitch upgraded South Korea’s credit rating on the same grounds as Moody’s. Fitch gave high marks for the economic and financial stability South Korea has secured amid the highly volatile global economic environment. The ratings agency said that the nation is entitled to receive the double A rating considering its strong fundamentals, such as a strong macroeconomic policy framework, income levels, and social and political stability. Meanwhile, the agency downgraded Japan’s credit rating by two notches from AA to A+ in May, citing a sharp increase in public debt. Japan’s public debt-to-GDP ratio exceeds 200%, whereas Korea’s public debt ratio stands at just 32%.

In terms of financial integrity, Fitch highly evaluated South Korea for its sustained fiscal discipline, low public debt ratio, and excellent fiscal balance amid its slowing economy and upcoming presidential election. Bloomberg said, “South Korea’s debt rating was upgraded by Fitch Ratings to AA- less than two weeks after a similar move by Moody’s. This reflects the nation’s financial stability.”

The ratings agency explained that, in terms of real economy, South Korea recorded a higher real GDP growth rate than the AA rating group from 2007 to 2011, while its growth and price volatility were lower than the group over the same period.

South Korea was also highly praised for its strengthened international financial standing: a decrease in its short-term foreign debt, an increase in its foreign reserves, and an improvement in banks’ capabilities for overseas financing, which was done in compliance with the government’s measures to combat volatile capital flow.

Fitch predicted, “If South Korea continues to maintain sound financial conditions and reduces its public debt, it will have its credit rating upgraded another notch. As a result, it will be able to afford to ease the heavy financial burden of supporting its aging population.” It added, “If the asset quality or liquidity of Korean banks that lent heavily to debt-ridden households and SMEs deteriorates, or if North Korea collapses suddenly, South Korea’s rating will be downgraded.” However, it added that the chances of this are extremely low.

Economic Effects Associated with Upgraded Credit Rating

With the recent upgrades pushing up South Korea’s international credit standing, it is expected to generate huge tangible and intangible economic effects.

The Korean economy has experienced significant changes since Moody’s revised up its credit rating one notch on August 27. Specifically, South Korea’s credit default swap (CDS) premium, which reflects the risk of a nation going bankrupt, slipped to a double-digit figure as of September 5. With this, the nation outperformed China for the first time in 6.5 years in terms of CDS premium.

Furthermore, the upgraded credit rating of South Korea will lead to enhanced ratings for Korean financial institutions and companies, which in turn, is expected to reduce their overseas financing costs. A one-notch upgrade is likely to create savings of US$400 million (454 billion won) in terms of annual interest costs on foreign borrowed money. Korea Development Bank (KDB) successfully issued 10-year publicly offered dollar bonds worth US$750 million at an interest rate of US Treasuries plus 155bp on September 6. In addition, government-run banks have issued 10-year publicly offered bonds at an average funding rate of US Treasuries plus 270bp since last August.

The nation’s higher credit rating is also expected to turn around investor sentiment in both stock and bond markets. In particular, foreign investors will increase their investments in Korean Won bonds. News agency Reuters said, “Fitch gave Korea a rating one notch higher than those of China, Japan, and Taiwan. This will strengthen investor perception in stock and bond markets that Korean bonds are safe assets.”

The recent moves by Moody’s and Fitch are expected to affect Standard & Poor's (S&P) rating. S&P, which places an emphasis on North Korea risks, has awarded an A rating to South Korea, a lower grade than those given by the other two major credit rating agencies. The agency gave AA- ratings to China and Japan, two levels higher than South Korea. Reuters expects S&P to revise up its credit rating for South Korea. The news agency said it will be interesting to see whether S&P will follow the other two major agencies and upgrade South Korea’s debt rating because it has maintained Korea’s rating at A since 2005.

Challenges Ahead for South Korea

The Ministry of Strategy and Finance (MOSF) said, “The latest upgrade by Fitch following the move by Moody’s last month suggests that our nation is well praised by international market for its economic health and macroeconomic management.” It added, “Two global credit rating agencies have upgraded our nation’s rating at a time when major countries are seeing their grades downgraded. This is really unheard of.” The Dow Jones Newswire stated, “The recent announcement by Fitch has resulted in the perception that South Korea has economic fundamentals strong enough to weather the global economic crisis.”

However, Fitch’s warned that public corporations debt, household debt, and North Korean issues are risk factors that could hurt South Korea’s credit rating. Enormous household debts here, which have already swollen to over 900 trillion won, are often seen as a time bomb. Public corporation debt is not an immediate threat to the Korean economy, but continues to grow quickly.

Worse yet, the government’s fiscal burdens are becoming out of control due to an aging population and excessive demand for more welfare programs. Demand is also growing for a supplementary budget to be introduced to stimulate the economy. Indeed, the government has delayed the target year of achieving a public debt ratio of less than 30 percent from 2014 to within 2016 due to sluggish growth and increasing government spending. The government should give priority to its financial integrity in dealing with the expansion of welfare spending or to economic stimulus measures. Most of all, a sharp distinction between politicians’ empty promises and real ones is urgently needed.

The Eurozone financial crisis has had devastating implications for the world’s three largest markets: Europe, the US, and China. Consequently, South Korea’s exports are slowing and its domestic consumption losing steam. In addition, there are growing concerns that the nation’s economy will only grow in the two percent range. This predicted slow growth is raising the possibility that the nation will soon face a Japanese-style long-term L-shaped recession. Japan, the world’s third largest economy, retained the highest triple A rating until the late 1990s. However, the Japanese economy then slipped into a ten-year long recession followed by another ten-year long recession. As a result, Japan’s credit rating was lowered four notches to A+. This should serve as a wake-up call for South Korea, which would not be immune to a long-term recession.

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